Holding Onto Hovnanian, With Some Trepidation

A gut call that has not worked out well was my purchase of Hovnanian (NYSE:HOV). I will focus on a homebuilder who honestly does not have any material value at the moment from my models (ie fair value very low) – this purchase was from my gut and belief about where things are going in the future.

Based on the action thus far since the purchase, I am not super confident that this trade will be a success. However, this is a long term trade using a long term options.

In going through recent news on HOV, management appears to see stability within their earnings streams. They are looking at improving cancellation rates and better traffic. At the same time, earnings are not exactly arguing for stability and they still have a very large exposure to the hot markets such as Florida (though exposure is limited in the Northeast – no Massachusetts or New England – which is somewhat of a positive).

HOV said at a recent UBS conference, “Anticipate a “boat hull” recovery…not “U” shaped recovery or V shaped recovery.” Interestingly since this conference, the stock has not had a boat hull, U or V shaped move – more like an “I” move…as in straight down!

There are a few factors working for HOV that have historically helped the stock price in moving higher. The first is the inventory of unsold homes per community. In the UBS presentation, HOV shows that the level peaked last fall and is trending lower moving towards 2005 levels. In addition, first quarter cancellation rates came in at 29% (excluding the Fort Meyers Cape Coral Operations).

This would be the lowest first quarter cancellation rate (as a % of gross contracts) since Q405 and the best first quarter cancellation rate since Q105 (27%). Finally, HOV posted a chart of the University of Michigan’s “Overall Home Buying conditions.” The trend bottomed around a 1991 low a few months ago and has been trending higher since. This indicator, along with the inventory and cancellation rate indicators have generally led to a higher HOV stock price – recent history does not represent such. This is part of the reason I am a buyer at the moment.

In addition to these tidbits, a few other metrics in my models show support. The Earnings Momentum Indicator, which has been in a downtrend since the summer of 2005 (when the stock was at $67) turned up last week to the positive side. While not particularly strong, it does indicate that the dive lower is losing steam, earnings wise. In addition, while fair value is still lower than current levels, it is on the rise. Combined with another model that measures the current price versus the sames fair value, the stock is near levels where it bottomed previously. Outside of the stock models, the monthly chart shows the stock hanging out at the previous lows. If it is to find support, it may do so here.

All of this gives me the “guts” to buy HOV and add some (as it is oversold again last week). While there are plenty of risks to the outlook, I think I will be happy with this move in the longer term. If I am wrong, my stop sits around $20 to protect from another major break.
Fundamental View
The earnings picture is not a pretty one at the moment for HOV. Taking into account charges from the Fort Meyers operations, HOV is expected to lose .19/share this year. However, next year, the company is forecasting 1.10 to 1.50 (tremendously wide range). The market is looking generally for $1.19. These metrics made the stock quite expensive but if the market able to show some stability, those 2008 numbers will probably get revised higher. Overall, the fundamentals though are not exactly supportive.

The Trading Model
The trading model is again oversold this week for HOV. As a matter of fact, the stock is trading at its weakest levels since last spring when the stock fell from the $50 level to the $30s. As I mentioned above, HOV is trading at an extreme level to its fair value on the downside which in the past has lead to a bounce higher in the stock (last being a move from 28 to the 36 area). The sector as a whole is oversold of the stock I follow – this has been the case now for four weeks. This trade is very similar to the trade of last may which hammered the sector lower but eventually led to a good bounce higher in the months ahead.
The Charts
As the attached chart shows, HOV is right at the bottom of a triangle formation. Needless to say we are at a point where the stock is set to break down in a large way or bounce higher out of the triangle formation. Since I am long, I am playing for the latter and not the former! There is a possible divergence forming on the ADX between selling and buying pressure – a bounce here would confirm such. The same is occurring with the RSI as well setting up a class double bottom formation. The question now is whether the stock confirms these divergences.

Summary
So with great risk involved, I added to my position in HOV on Thursday. I was only holding a 25% of normal position coming into this week but since my stop is about 4 points lower, I think the risk rewards is worth it at this point. I have chart support and my trading models support – I just need the fundamentals and perception to improve. We’ll see what happens.

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